Growing More Confident Q1 '16 Earnings Will Be The Bottom

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Includes: BXUB, BXUC, EPS, IVV, LLSP, RSP, RWL, RYARX, SDS, SFLA, SH, SPLX, SPUU, SPXL, SPXS, SPXU, SPY, SSO, UPRO, VFINX, VOO
by: Brian Gilmartin, CFA

Thomson Reuters earnings data for April 1 '16 did NOT include the updated "forward 4-quarter earnings estimate" which would be the bottom-up estimate for Q2 '16 through Q1 '17. The updated number will come with next Friday's "This Week in Earnings" dated April 8, 2016.

However, if Q1 '17's estimate is extrapolated based on first quarter history (let's assume a relatively conservative $30.00 for the quarter), then the forward 4-quarter estimate should be between $123 and $124 next week.

For Q1 '16, according to Thomson Reuters the current bottom-up estimate is $26.39, which, if it turns out to be accurate, will be the lowest dollar estimate for the S&P 500 since Q1 '13! However, the trend is that the dollar estimate and the expected growth rate typically hit their lows just prior to the quarterly earnings reports starting, and then work gradually higher from there.

The Energy sector, roughly 5% of the S&P 500 by market cap is expected to show -100% earnings growth for Q1 '16 (much of that no doubt, as a result of Energy companies issuing stock, resulting in dilution), while Basic Materials is expected to decline 19%. Even the Financial sector has seen a negative 900 basis point negative change in earnings growth, from an expected +2.4% on January 1 '16 to -6.8% today.

Expect those sector earnings drags to start to diminish as we move through 2016.

I'm growing increasingly confident that Q1 '16's earnings "growth" will be the low for the benchmark, and future quarters should start to show year-over-year growth from here.

Why?

1.) Commodities have been in a 5-year bear market, but have also started to stabilize. Even if Energy and Basic Materials don't show Nascar-like earnings growth, just price stability in the core commodities should help forward estimates;

2.) The dollar is trending the right direction - again, it doesn't need to materially weaken, just not strengthen dramatically.

3.) Financials - the bounce in commodities should start to alleviate the pressure on Financials. The drop in Financials in Q1 '16 (one of our largest sector weightings for clients unfortunately) resulted in Financials falling to the third largest sector market cap in the S&P 500 behind Technology and Health Care.

However, Financials by market cap is still 15% of the S&P 500 and matters in terms of the index performance.

In fact if Technology, Health Care and Financials returned to 10% earnings growth each (and historically that isn't a big stretch or leap of faith), you wouldn't really care what the rest of the S&P 500 did, since your portfolio would show healthy returns.

S&P 500 earnings data by the numbers: (Courtesy of Thomson Reuters and some patchwork extrapolation):

  • Forward 4-quarter estimate: $123.50 (estimate expected next week)
  • PE ratio: 16.7(x)
  • PEG ratio: barely positive
  • S&P 500 earnings yield: 5.96%, moving back towards 6% with the increase in the forward estimate
  • Year-over-year earnings growth: even with the $123.50 estimate, negative at -0.35%. As long as that growth rate moves into positive territory as it has been this year, (just barely) and gradually increases, the S&P 500 should continue to see a slow bid.

Analysis / conclusion: There are some other sector-related earnings numbers I could show readers but it is navel gazing at its finest. There are other reasons I am more bullish on S&P 500 earnings than were detailed here, but the numbers need to be laid out for readers and it isn't "easy reading". The sentiment around S&P 500 earnings is really bad and I continue to read on Twitter and other blogs (particularly from those with a bearish bent) how S&P 500 earnings are pretty bad, and my first thought is usually, "OK, but who doesn't know that?"

No question, the commodity stocks have started to rebound, but the earnings data hasn't yet followed. I'll be out with some examples over the next few days, with some other thoughts too.

Since crude oil peaked in mid-2014, there has been a malaise around S&P 500 earnings, and the dollar, which has filtered into Financials. Technology and Health Care suffered from their own issues (Apple (NASDAQ:AAPL) peaked at $135, while biotech and large-cap pharma became a victim of election rhetoric.)

Remember, a lot can still go right.